China is currently the second largest consumer of energy in the world (behind the US) and is projected to overtake the US as the largest consumer by 2015. To meet its growing energy needs, China has made impressive efforts in recent years to expand its renewable energy capacity. This effort was kick-started with the passage of the Renewable Energy Law in 2005. After four years of rapid expansion in China’s renewable energy sector, China passed amendments to the Renewable Energy Law on December 26, 2009. While it still remains to be seen what the exact impact of the amendments will be, the amendments illustrate China’s continued commitment to expanding its renewable energy supply and overcoming some of the existing barriers to achieving this objective.

The original Renewable Energy Law created an umbrella framework for regulating renewable energy in China. (Here is the text of the original law in English and Chinese). Like many laws enacted in China, the Renewable Energy Law left many of the important details to be determined later by various government agencies through regulation. Since the Renewable Energy Law went into effect on January 1, 2006, numerous regulations have been issued to fill in some of these details. Although the amendments do not alter the underlying policy goals of the original law, they do add additional detail to the existing framework to improve implementation of the law’s underlying goals.

In this blog post, I’ll focus on two significant changes: (1) the addition of measures intended to better implement the Mandatory Connection Policy and (2) the streamlining of the renewable energy fund that provides the financial incentives for the renewable energy industry. We will release a more detailed report on the amendments in a few weeks.

1. Changes to the Mandatory Connection Policy

One of the most significant aspects of the Renewable Energy Law when it was originally passed was the introduction of the “Mandatory Connection” policy, which essentially required grid companies to connect and purchase all renewable energy generated that could be fed into the grid. After four years of experience with the Mandatory Connection policy, however, it became clear that not all grid companies were complying with their obligations to purchase all renewable power and connect it to the grid (See here in English and here Chinese in Section 3 for more detail).

While China has rapidly increased its installed capacity of renewable energy over the last five years, there are concerns that too much of this capacity is not promptly connected to the grid and that not all power being generated is being purchased as required by the law. For example, China’s installed wind capacity has doubled every year for the last four years, but according to recent reports, about 30% of China’s wind capacity is not connected to the grid and may be lying idle. China has recognized that this “bottleneck” problem is a serious issue that must be resolved in order to achieve its renewable energy potential and reduce the growth of its greenhouse gas emissions (See here in English and here in Chinese).

This “bottleneck” is due, at least in part, to the fact that oftentimes grid companies lack the necessary infrastructure to connect all of the renewable power generated and that adequate incentives are not in place to encourage them to invest in upgrading their infrastructure. According to some sources in China’s wind industry, grid companies in some cases have even required renewable energy generators to agree in their power purchase agreement to a grid curtailment provision (i.e. that only a portion of their energy generated will be purchased by the grid), which is a clear violation of the Mandatory Connection Policy. As a practical matter, however, curtailment of power generation may be necessary at certain times if the amount of power generated at a specific time is more than what the grid can securely handle. Much of the amendments are aimed at addressing this “bottleneck” problem by creating a legal framework that requires grid companies to invest in expanding and strengthening their facilities.

One useful lens through which to view the amendments is to look at how the responsibilities of the grid companies have increased and decreased under the amendments. These responsibilities have increased most notably by now requiring that grid companies meet a new type of target- a proportion of renewable power generated relative to overall power generation (Art. 14, paragraph 1). Although the amendments do not themselves specify any amounts, they direct certain government agencies to set the amounts of these targets and enforce them. This new requirement essentially provides for a system similar to the Renewable Portfolio Standards (RPS) that are found in various US states. China has set several different renewable energy targets in the past, but this new target differs from previous targets in some significant ways.1

Unlike any of the previous targets, the new target created by the amendments places responsibility directly on grid companies to purchase a fixed share of their power generation from renewable energy sources, and these grid-level targets will be enforced through penalties for non-compliance (Art. 29). A Mandatory Market Share (MMS) that sets the percentage of non-hydro renewable power generation out of total power generation was introduced in 2007 in the Mid and Long Term Plan for Renewable Energy that was issued by China’s chief national economic planning agency, the National Development and Reform Commission (NDRC). (See here in English and here in Chinese) While this 2007 target is similar to the new target provided for in the amendments, this is the first time in China that an RPS-style target has been expressly provided for in the law, creating an enforceable, legal obligation with which grid companies must comply.

There are a number of open questions about how these targets will be implemented. Here are a few suggestions for China to consider when formulating the implementing regulations:

The targets should be set on an annual basis and the magnitude of the targets should increase gradually and predictably every few years. The target should continually increase in order to drive the development of additional renewable power generation. In addition, hydropower should continue to be excluded from the target (as it is under the MMS policy mentioned above).

The penalty regulations should be drafted in such a way that penalties for non-compliance are imposed automatically without any discretion to ensure that the target is being uniformly enforced. In addition to the penalty, the grid company should be required to make up any shortfall in the following year to alleviate any incentive that grid companies may have to pay the penalty rather than comply.

In addition to financial penalties, it is worth considering a performance evaluation system for grid company officials based on their performance in meeting their assigned targets. Performance evaluations of government officials, which determine whether officials will be rewarded or punished, have proven to be one of the most effective tools in ensuring that China’s centrally determined targets are met nationwide.

To verify that grid companies are meeting their targets, they should submit copies of all of their power purchase agreements with renewable power generators as well as file an annual report detailing all the power purchased throughout the year. This annual report should be made public and subject to substantial penalties for false or misleading information.

One question is whether it would be possible to implement a trading system in which grid companies could trade renewable energy credits (REC) for the excess or shortfall in meeting the targets. A trading mechanism has the advantage of increasing efficiency, reducing administrative costs and increasing flexibility. However, an adequate legal infrastructure must be in place for such a trading scheme to work. While it is unclear if such a system would currently be effective in China, a pilot trading scheme could be developed to help lay the ground work for a national trading system that could be implemented in the mid to long-term.

Since renewable energy technologies vary widely in their cost, the targets should differentiate between different types of renewable energy technologies (such as solar) to encourage the development of a diverse renewable energy portfolio. This could be accomplished by setting different percentages within the overall target for different technologies or by setting minimum or maximum contributions from certain technologies. The downside of these policies is they increase the administrative complexity in enforcing the targets.

While much of the detail still remains to be worked out, the amendments on their face clearly impose a new obligation on the grid companies that did not exist under the original legal framework.

On the other hand, the amendments also decrease the grid companies’ obligations by adding a new provision that would limit the scope of the grid companies’ obligations under the Mandatory Connection Policy. The original law required grid companies to purchase all renewable energy that was available for feed-in to the grid regardless of “quality,” but the amended law now limits grid companies’ responsibility to only those renewable energy generators that meet certain technical requirements for connection (Art. 14, paragraph 2).

The argument for such a policy is that if power generated from renewable sources (such as wind) is variable then connecting it to the grid could increase the vulnerability of the entire network and increase the cost of integration for the grid company. For example, wind integration studies in the U.S. have found that the cost of integrating wind into the grid is generally around $5/MWh for wind capacity penetration levels of up to 20%. In the U.S., the development of grid codes by the U.S. Federal Energy Regulatory Commission has helped to advance wind turbine technologies that ultimately make it easier to integrate wind projects into the grid.

While setting compulsory national technical standards is a positive step, one issue with the amendments is that they do not specify who will set the standards and how they will be monitored. Although technical guidelines for wind, solar and geothermal were issued in China in 2005, compulsory national standards do not currently exist. We suggest that these technical standards be developed through an inclusive, transparent process; otherwise, this exception could end up swallowing the rule and undermining the goals of the Mandatory Connection policy.

In sum, the grid companies’ obligations have both increased and decreased in some respects as a result of the amendments and it remains to be seen how the balance will ultimately be struck.

(As an aside, there have been numerous media reports that China has increased its penalty provision for grid companies’ non-compliance in Art. 29. This assessment is incorrect and likely stems from a faulty translation of either the amendments or the original law. The amendments do not impose any additional penalties than what already existed in the original law.)

2. Streamlining the Renewable Energy Development Fund

One other very important change to the law is how grid companies are compensated when purchasing renewable energy instead of cheaper, dirtier forms of energy, such as coal.

Given that renewable power is generally more expensive than conventional fossil fuels, China has instituted feed-in tariffs for a variety of renewable energy technologies to compensate grid companies for the additional cost of purchasing renewable energy. The original law created a system in which these feed-in tariffs and additional costs associated with connecting a renewable generator to the grid would be funded by a surcharge on end-users of electricity.

Under the original law, the grid company would directly withhold the surcharge from the end-user’s regular electricity bill. This surcharge is set by the government and is periodically increased (as of Nov. 2009 the surcharge is set at RMB .004/kWh). Now, instead of the grid companies’ collecting the surcharge directly from the end-user, the end-user will pay the surcharge into a Renewable Energy Development Fund. Once the surcharges have been pooled, the grid company will then seek compensation from the fund for the additional cost of purchasing the renewable energy, including the costs associated with integration. Although this change might seem like a mere technicality, it is actually quite significant because pooling all the surcharges into one large fund will allow the government to use this considerable amount of money (689 million USD in 2009 and an estimated 1 billion USD in 2010) not only to compensate grid companies, but also to invest in various renewable energy development projects, including R&D (Art. 24). In order for the fund to be effective at funding these types of projects, we suggest that a transparent application process be established including detailed eligibility criteria for applicants to the fund in order to ensure that fund is applying its capital efficiently towards the most qualified projects.

The other benefit of the new funds-flow process is that it will allow the surcharges collected in China’s wealthier, eastern provinces to be spent in China’s less developed western provinces, where some of China’s richest renewable energy resources are located (Art. 21). Although surcharges have been manually re-allocated under the current regulations, now, by pooling the surcharges into a central fund, it will allow China to move ahead with a unified, national renewable energy plan that balances the renewable energy potential of China’s western provinces with the needs of its economic centers in the east.

As noted above, there are a number of questions raised by the amendments and we will have to wait for the release of the implementing regulations before any conclusions about the amendment’s overall success can be made. Nevertheless, the amendments illustrate that China is pushing ahead with its vows to clean up its energy supply and is working on overcoming some the barriers that have stood in the way of achieving this goal.

1 Below are of some of China’s key national renewable energy targets that were released in 2007 (prior to the enactment of the amendments) in NDRC’s Mid and Long Term Development Plan for Renewable Energy”:

China “will aim” to have 10% of primary energy consumption by 2010 and 15% of primary energy consumption by 2020 come from renewable energy sources;

Non-hydro renewable power generation’s share of total power generation in areas covered by large-scale power grids should reach 1% by 2010 and over 3% by 2020; and

Power generators that have privately-owned installed capacity of over 5 GW are required to have 3% of their total privately-owned installed capacity come from renewable energy by 2010 and over 8% by 2020.

The new target announced in the amendment differs from the above targets in that the new target creates a legal obligation at the grid company-level to comply with the renewable energy target or face penalties for non-compliance.